The Nobel Series : Bounded rationality

The 1978 Nobel Prize in Economic Sciences was awarded to Herbert Simon for his original research on decision-making processes within economic organisations. Simon was a true polymath and made contributions not only in social sciences such as economics, political science and psychology but also applied mathematics, statistics, operations research and

business administration. Simon's works paved the way for more path-breaking research in areas such as Artificial Intelligence, complex systems and organisation theory.

Simon is however best known for his concepts of bounded rationality and satisficing, which are developed in his well-known work 'Administrative

Behaviour'. According to Simon, there is a distinction between entrepreneurs and enterprises. Moreover, the rudimentary theory of the firm takes the objective of the firm to be profit maximisation.

Simon challenged this theory and also rejected the notion of a firm as an all-knowing entity which could rank all alternatives and arrive at the one giving maximum profits. As the Nobel Prize website tells us:

Influenced by the organisational research that was being conducted in other social sciences, however, economists in the 1930s began to look at the structure of companies and at the decision-making process in an entirely new way. Simon's work was of the utmost importance for this new line of development. In his epoch-making book, 'Administrative Behaviour' (1947), and in a number of subsequent works, he described the company as an adaptive system of physical, personal and social components that are held together by a network of intercommunications and by the willingness of its members to cooperate and to strive towards a common goal. What is new in Simon's ideas is, most of all, that he rejects the assumption made in the classic theory of the firm of an omniscient, rational, profit-maximising entrepreneur. He replaces this entrepreneur by a number of cooperating decision-makers, whose capacities for rational action are limited, both by a lack of knowledge about the total consequences of their decisions and by personal and social ties. Since these decision-makers cannot choose the best alternative, as can the classic entrepreneur, they have to be content with a satisfactory alternative. Individual companies, therefore, strive not to maximise profits but to find acceptable solutions to acute problems. This might mean that a number of partly contradictory goals have to be reached at the same time. Each decision-maker in such a company attempts to find a satisfactory solution to his own set of problems, taking into consideration how others are solving theirs.

In this article, we will review the major works of Herbert Simon and see how they are relevant to public policy.

Main works

Simon joined the University of Chicago in 1933 for his undergraduate studies in social sciences and mathematics. While he was more interested in biology, he couldn't pursue it because of his colour blindness. His mentor at Chicago was Henry Schultz, who was an econometrician and mathematical economist. Ultimately he ended up getting his BA and PhD in political science because of the nature of his study i.e. decision theory in organisations. He finished BA in 1936 and PhD in 1943 from the University of Chicago. After his PhD, he taught political science in the Illinois Institute of Technology in Chicago and began participating in the activities of the Cowles Commission. At the Commission, he began work on the economics of institutionalism. In 1949, he shifted to Carnegie Mellon University as Professor of Administration and stayed there till he retired.

His most well-known work 'Administrative Behaviour' was published in 1947 and was based on his PhD dissertation. In this book, Simon proposed two of his best-known theories, namely bounded rationality and satisficing. Simon studied the behavioural and cognitive processes of human decision-making in great detail. He departed from the Homo Economicus characterisation of human beings of neoclassical economics, who are perfectly rational and have a good idea of all the alternatives. They have the capability of ranking these alternatives in order of their preferences. In his words:

[If] there were no limits to human rationality, the administrative theory would be barren. It would consist of the single precept: always select that

alternative, among those available, which will lead to the most complete achievement of your goals.

Accordingly, for Simon, human beings were more Homo Psychologicus than Homo Economicus. Hence, alternatives could be partly known and means and end imperfectly differentiated, incompletely related, or poorly detailed. This was because it was simply impossible for a human to identify and list all the alternatives, determine all consequences resulting from each of the alternatives and then choose the consequences that were most efficient.

'Administrative Behaviour' speaks of 'administrative man' versus 'economic man' and issues of authority and loyalties. Further, Simon also differentiated between the psychologists' "procedural" definition of rationality, against the economists' "substantive" definition.

As mentioned above, it was Simon's theory of bounded rationality and satisficing that are considered to be fundamental contributions to social sciences in general and economics in particular. He worked to distinguish these concepts from the rationality assumption of neoclassical economics. At the individual level, we saw above that the demands of rationality on a human mind were far too much. Similarly, Simon thought that firms could not always maximise profits, simply because there was incomplete information and an uncertainty. Hence, economic agents such as individuals and firms were 'boundedly rational' and must make decisions by 'satisficing' rather than optimising. Bounded rationality is thus a theory about economic decision-making, which says that there is a limit to the limitless rationality which is assumed in the neoclassical model. This limit is basically a cognitive limit as well as a limit of information and knowledge. And "satisficing" is a combination of two words: "satisfy" and "suffice", which simply means that individuals seek something that is "good enough", something that is satisfactory, rather than 'maximising' utility or profits.

Simon also wrote 'Models of Man: Social and Rational' which, in the author's words was, "a collection of mathematical essays on rational human behaviour in a social setting. The work employs mathematical formulae in support of the author's assertions regarding human behaviour". The book is about causation and influence relationships, social processes, rationality and administrative behaviour.

Public policy

In addition to being the chairman of the University Department, Simon also contributed to policymaking in the US. He was an important team member who created the Economic Cooperation Administration in 1948 and the administrative team that implemented the Marshall Plan for the US Government. He also served on President Lyndon Johnson's Science Advisory Committee and the National Academy of Science.

Simon's works find widespread use in various areas of policy even today. He was an early proponent of Artificial Intelligence, which is a rage today. By 1965, Simon was certain that "machines will be capable of doing any work a man can do." He created the Logic Theory machine with Allen Newell in 1956 and the General Problem Solver program in 1957. The Logic Theory machine is nothing but a computer program to perform automated reasoning. This program solved 38 of the 52 theorems of Principia Mathematica. The General Problem Solver was also a computer program which served as a universal problem solver. Simon extended this work to apply Artificial Intelligence to even emotional cognition. He was awarded the Turing award in 1975 jointly with Newell. Simon was almost prophetic when he predicted in the 1960s that

the environment will become a pressing concern in the coming decades. Even at that time, Simon was talking about sustainable energy and environmental pollution.

Another relevant public policy application of Simon emanates from his theories and observations about decision-making in organisations. These apply very well to decision-making in modern businesses and public administration. In fact, Simon's works also paved the way for much of the future work on economics of organisation done by the economists Ronald Coase (Nobel Prize winner in 1991) and Oliver Williamson (Nobel prize winner in 2009) and on a behavioural approach to organisations done by the psychologist James March.

Simon's work in psychology on cognition and learning processes is still the basis of many applications in psychology. We may recall that Simon had developed a computer program modelling human learning (the program was called EPAM or Elementary Perceiver and Memoriser), which was later developed further and even found applications in developing expertise in Chess. Simon's work in cognition also paved the way for Kahneman's work (who won the Nobel prize in 2002). Kahneman took forward Simon's ideas of bounded rationality and satisficing and suggested that individuals used heuristics as guides for action, rather than being the perfectly rational agents of neoclassical economics.

Conclusion

Simon wanted to develop a deeper understanding of decision-making and human cognition, for which he used computer programming. He was far ahead of his times, having proposed the early Artificial Intelligence applications. Simon's work provided a new way of thinking in a variety of areas of social sciences, but particularly in microeconomics (decisions under uncertainty and incomplete information) and human behaviour in organisations (bounded rationality and satisficing). His work has found resonance in a number of public policy areas from the environment to decision-making in organisations.

Views expressed are personal